Dollar stores' struggles sidestepped by one that accepts loonies

Dollar stores have been going through a tough slog in the U.S., but business is booming north of the border for Dollarama Inc.

Shares of Canada's biggest discount retailer touched new highs late last month after beating analysts' earnings estimates, raising its margin forecasts and accelerating expansion plans. Meanwhile U.S. counterparts Dollar General Corp. and Dollar Tree Inc. have plunged 20 percent or more from recent highs.

Dollarama's secret? The same penny-pinching strategy as its customers.

By staying away from fresh food, keeping costs low and relentlessly testing new ideas, Dollarama has avoided pitfalls that tripped up competitors, according to Chief Financial Officer Michael Ross.

Unlike U.S. rivals that saw opportunities in using food to attract customers, Dollarama was unscathed by a recent run of food deflation that hurt margins for grocers and discounts chains on both sides of the border, including Metro Inc.

"We want to make sure that we keep our costs to the lowest level possible, allowing us to give more value to our customers," Ross said in a phone interview Friday. "In a dollar-store environment, you're managing pennies, and your margin for error is very small."

Founder Larry Rossy, a third-generation retailer who was succeeded last year as chief executive officer by his son Neil, converted the small Quebec-based family chain to the dollar-store concept in 1992. Dollarama now manages almost 1,100 stores across in Canada, including 26 added in the past quarter.

Its closest competitor is Chesapeake, Virginia-based Dollar Tree, which operates 226 stores north of the border. The U.S. retailer, with more than 14,000 stores in all, entered the country via an acquisition in 2010 and said in its latest annual report that the revenue and assets there "are not material."

"Dollarama has defined the dollar segment in Canada, grown the segment and increased its share," Keith Howlett, an analyst at Desjardins Capital Markets, said in a note where he also raised his target price on the stock to $C120 ($90.10) from C$116. "No external competitive impediment to Dollarama is currently visible."

Canadians turn to Dollarama's yellow-and-green bannered stores for party accessories, kitchenware and seasonal goods like Halloween decorations. While some chips or candies are on display, there's no milk, eggs or frozen meals. Consumable products account for 38 percent of the value of merchandise offered. Dollar General generates roughly 75 percent of sales from such items.

Dollarama has invested in technology to boost productivity, builds stores in a consistent "10,000 square-foot box format" and stays away from advertising. It changes about a quarter of its offerings every year, according to Ross, who joined in 2010.

The company says it plans to open 1,700 stores in the next eight to 10 years, more than the 1,400 previously anticipated. The decision was made after looking at population trends, competition, the company's own results and real-estate opportunities, Ross said.

According to Barclays Capital, that would help bring the number of dollar stores in Canada close to U.S. levels, at about one outlet per 15,000 people.

The Montreal-based retailer was bought by Bain Capital in 2004, which took the company public five years later and sold its stake in 2011.

In U.S. dollar terms, Dollarama shares have returned 254 percent over the past five years, almost four times the gain of the Bloomberg Intelligence Dollar Store index, while the broader Toronto S&P/TSX Composite Index has advanced 8.2 percent.

The company, which buys more than half of its goods outside of North America, would benefit if the Trump administration implements a border tax on imported goods, which would hurt U.S.-based retailers, said Bloomberg Intelligence senior analyst Poonam Goyal.

CEO Rossy told analysts that "a slightly soft Chinese market" helped boost margins in the quarter ended Jan. 29, by lowering purchasing costs. The company's profit for the period beat the highest forecast as customers spent more per visit, snapping up C$3.50 and C$4 products that were recently added. The company started introducing different prices in 2009 after 17 years at $1.

"We could go for another 17 years with price points up to C$4 easily," Ross said in the interview. "There's no obligation to introduce higher price points for a while."

With the amounts per customer rising, the company will now accept credit cards.That wasn't a quick decision. Credit cards were first tested five years ago, a testament to how the company proceeds with important decisions, according to Ross.

"We'll test the hell out of it before introducing it," he said.

That also applies to international expansion, which the company is taking slowly. Rossy told analysts he's using an agreement struck in 2013 with Dollar City, in Central America, to learn "how to handle international expansion in an extraordinarily conservative way."

Dollarama, which supplies products and operational expertise, has the option to buy control of the company in 2020.

"We just want to make sure that if we implement it, it's going to work right away," Ross said in the interview. "You have to make sure you got the best resources around you, test it, test it, and test it again, and make sure that it works, and then you implement it — and that comes from the Rossy culture."

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